The Problems Behind Discounts: From Pilled-up Inventory to a Vicious Cycle

If you, like me, it’s trapped in your place but still don’t live under a rock; you have seen fashion brands and retailers advertising many new discounts. You may even be planning a post-pandemic shopping spree at all these stores that will be — if are not already — on sale. And that’s actually perfect because we are all broke. Yep, amazing right? Well, not really.

These discounts that are already being seen and will definitely rise once stores reopen are related to a huge problem for fashion retailers and brands: piles and piles of unsold inventory. The lockdown measures amid the pandemic made fashion sales drastically drop, resulting in one of the largest inventory crises in the history of fashion. But it was just a matter of time for this issue to get to such large proportions because excess inventory and discounting are problems that have been growing for years now. The roots of the problem are actually deeper and more complex than just the coronavirus closing stores and affecting sales.

The Change of the Discounting Culture

Do you remember when a fashion store with too many markdowns out of the sales season was assumed to be experiencing difficulties — if not closing? I still remember buying some coats with a 70% discount at Benetton and leaving the store sure the markdown meant the store was not doing well. One week later, they closed their last store in my hometown. We just expected to see healthy businesses with markdowns during sales season with the few products left that were never our size. The purpose of discounts was to sell what was left to give space to the new collections, which would come in season — usually spring/summer and fall/winter. But then things changed.

The first sign of a massive change in discounting culture that I could find was in the US after the 2008 financial crisis. A financially insecure population made fashion retailers decide to jump on discounts to get rid of piles-up stocks. But this change had different timings in different markets. In 2015, I remember traveling to Europe and getting impressed with the aggressiveness of discounts compared to my country, Brazil. However, soon Zara was doing the same in Brazil, and competition followed. With no time, we all had five retailers at the top of our minds that were constantly on sales and were stable businesses. But why did this happen?

Seasons Started to Last a Week and Discount Mindset Took Over

The new era of discounting is a reflection of the increasing bargain power of consumers. In the past, fashion was mostly a supply-led market. Retailers offered the products they had chosen when they thought it was better and consumers would have to buy what was available. With the Internet adding social media and e-commerce to the mix, consumers became able to shop from anywhere in the world and easily compare prices. Also, the abundance of instant information online gave consumers an insatiable desire for new stuff that they expected brands to satisfy immediately. Demand took the place of supply as the controlling force of the fashion industry.

To cope with this craving for newness, brands had to adapt to the concept of weekly drops, popularized by the fast-fashion business model. People were buying more clothes than ever, and brands were producing to keep up with this rhythm. With a larger quantity of products being produced, a proper inventory depended on high turnover.

The problem is that, due to the usual lead times of the supply chain, fashion brands still have to produce the majority of their products with months in advance. Fast production and delivery are expensive, so, to fill up the stores with more affordable products with better profit margins, fashion buyers have to guess what customers will want in a few months. But very often their guesses are not accurate, resulting in excess stock. H&M, for example, accumulated $4 billion in unsold inventory at a certain point in 2018. In addition, the cost-effectiveness of clothing production at scale made many brands prefer to over-manufacture by 30% to 40%, instead of risking to run out of stock.

All these factors made waiting for the end of the season to start sales a complicated choice. New items were arriving every day and trends changed in less than a month. Waiting could mean keeping a product that no one wanted anymore at full price. WGSN, for example, conducted a research on US fashion stores, analysing the volume of discounts on current season products (products available for less than three months) in 2018 and 2019. The research revealed that the percentage of on season products discounted was staggering and growing. The results (image below) exposed that retailers were not only always offering discounts, but also not waiting for long to markdown recent pieces.

Then, if a retailer’s competitor started to offer more discounts, the retailer had to do the same to stay competitive. Finally, a battle of who had better discounts, lower and more frequent, started, with many fashion businesses compromising their profit margins, while, somehow, staying financially healthy. Margins are important for fashion companies, but so are turnover and sell-through. These need to be in constant equilibrium. In a fast-paced period of trends that come and go, margins were the ones being more sacrificed.

And it is not just the fast-fashion sector that goes through that. The luxury fashion sector had the largest volume of markdowns during last year’s Black Friday, with 46% of its products discounted. Exactly, discounting is a phenomenon that reached all levels of the fashion industry.

The problem is that customers rapidly got used to retailers offering larger and more often markdowns. A 2017 report from First Insight revealed that 45% of American women needed to see a discount of 41% or more to even consider entering a store. Many other studies around the globe had similar results, demonstrating that consumers were waiting for sales to shop. This is a phenomenon called discount mindset, which is extremely difficult to reverse. A reflection of that is the insane success of holidays such as Black Friday and Singles Day.

When the Strategies that Bring Success Backfire

If everyone is doing it and consumers love it, it can be hard to understand why markdowns are an issue. But they are a problem, a big one that retailers are aware of and have been trying to solve with little success. Brands with successful sales and that barely have inventory left at the end of seasons use the discounting strategy less. Gucci, for example, hasn’t done discounting since its return to success in 2015, not even during Black Friday, since their pieces were selling anyway. As stated by Robert Burke, founder and chief executive at Robert Burke Associates, early and excessive discounts are “generally not a positive sign. (…) Retailers would want to sell full prices as long as they could, meaning merchandise is moving well at full price”. Excessive markdowns are a sign of inventory problems.

Markdowns are costly for companies. The fewer pieces on discount, the better the company’s performance. I can say, from my personal experience in a fast-fashion company, that margins are often lower than what most consumers imagine them to be. Whenever we had to discount more than planned, and since I worked there during the Brazilian financial crisis, we did had to, the company would lose money. If necessary, some margins would even go to negative. All that to keep a healthy turnover and the inventory size under control. Do that too many times and that’s how your customers get used to markdowns and you get stuck in the vicious cycle of discount mindset.

But large companies with a strong bargain power are, of course, not paying the full bill of discounting alone. If fashion retailers are dealing with lower margins, they will pass along this loss by negotiating cheaper costs with manufacturers. In many negotiations, suppliers get to the point of giving up on profits just to keep big players as their clients. And if suppliers work with extremely low margins, their costs need to go down too. Thus, at the end of the day, the ones usually paying the most expensive price for our discounted clothes are the underpaid workers in the supply chain.

For luxury brands, too many markdowns may also mean damaging the image of the brand. Their high prices are justified by a subjective value proposition because luxury is about value, not cost. If luxury retailers offer discounts too often, they risk alienating consumers that don’t mind paying full price, making them question the brand’s value; and finally affecting brand equity in the long term. Outlets played a big part in the damaging of many luxury brands’ images. Lauren Sherman stated during a BOF live that Outlets represent a much larger share of fashion luxury sales than brands want to admit.

To avoid a discount mindset, many retailers would choose to destroy unsold products. However, after the scandal of Burberry in 2018, when the brand received backlash for burning £28.6 million in products, this practice became a risky PR move for companies. France even passed the first non-food waste ban in the world, forbidding the destruction of unsold items in the country. The issue is that sending leftovers to landfills became retailers’ second option to discounts, which is also not a sustainable solution. Ultimately, excessive markdowns are simply a sign of the much bigger issue of inventory management and excess

The Pandemic Gave Us One of the Worse Fashion Inventory Crisis in History

If the fashion industry was already dealing with inventory excess and discount mindset, it’s not hard to imagine that if this whole machine suddenly stopped, the problem would get to never seen before proportions. Well, it happened. The global pandemic gave countries no choice but to implement lockdown measures. Then, with the closure of stores and the lower demand from customers, the fashion industry became one of the most affected industries by the Covid-19.

Due to the radical decrease in sales, brands and retailers accumulated inventory, despite the efforts to cancel orders with suppliers. Fashion is living one of its worse inventory crises in history and specialists are already predicting it will most certainly cause the largest discounting season ever seen. According to the Edited retail analyst Krista Corrigan, in the fashion luxury sector, the number of goods in stock went 32% up year-over-year, while the number of products discounted increased by 29%.

Now, the main concern of fashion retailers is to get rid of what they can from their packed inventories. Scared of the consequences of extreme markdowns, many companies are looking for solutions outside discounting to solve the inventory problem.

The oil prices plumbed with the pandemic because producers don’t have space to store it anymore, getting to the point of paying ships to keep oil stored. Fashion and oil have a problem with inventory, but these industries work differently. In fashion, the inventory value gets worse with time, instead of being volatile to the demand like oil. Thus, storing products for next year is risky because they can get less relevant due to the fast change of trends, ending up on sale anyways, and wasting money on storage. As Walter Loeb stated for Forbes, “Much of the merchandise that was on the shelves and racks when stores first closed is worth less than 50% of its original value and soon will drop to 10%”.

However, some companies decided to keep some timeless pieces to sell them next year, such as Gap and Ganni. But Ganni is doing it with a twist. It will “upcycle” some clothes into new garments, an interesting approach, but too expensive to be followed by most brands.

Some Retailers with international presence chose the short-term strategy of transferring inventory to countries with better sales conditions, such as China that has reopened retail. Second-hand channels are also becoming another option to deal with stock excess. Some fashion brands are already sending products directly to channels such as The RealReal and Vinted, according to a BOF live discussion. The giant Chinese Alibaba even launched a new off-price platform called Luxury Soho to offer a premium space for luxury brands to send their inventory excess.

Retailers are trying, but, unfortunately, the most efficient solution for the inventory issue is still discounting, which will strengthen the already problematic discount mindset. This scenario will put an end to many fashion players, flood landfills with even more unsold items, and leave a large number of fashion workers unemployed. It’s a financial, social, and environmental problem without a perfect solution…yet.

Will We Learn From This?

I hope this long analysis of excessive markdowns, discount mindset, and excess inventory made it clear how the fashion industry should learn something from what is happening now. Until less than two decades ago, none of this was a spread issue, just struggling retailers would face such problems in these proportions. Maybe, remembering a bit how things use to be is exactly what we need to reverse this unhealthy cycle of discounting — as companies and consumers. The origin of everything, the inventory problem, got to a point that will take a while to recover from and we will need creativity and problem solving to turn the situation around. Luckily, the fashion industry is used to work with those.

Discounting is for fashion retailers what inflation is for countries: when in excess, it’s an extremely complex problem to solve that very often enters a vicious spiral and it’s a consequence of a much larger problem. Inflation was already controlled in many countries; we can do the same with discounting. We don’t know yet exactly how to do it, but I am sure we will figure it out.

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